As the taxes on cannabis stay, so will the illegal market.

Under Section 280E of the code, cannabis businesses are not allowed to take tax deductions on normal business expenses like employee salaries, rent and utility bills because the federal government considers their trade illegal drug trafficking — even where cannabis sales are legal under state law. As a result, the effective federal tax rate for legal cannabis businesses can reach 70% to 90%. No other industry has to operate with this very high tax rate.

Section 280E came into effect during the height of the drug war in the 1980s. A California cocaine dealer was gutsy enough to file his federal tax return with his drug income and expenses listed on it. When the IRS challenged the deductions for his illegal venture, the Tax Court sided with the dealer: There was nothing on the books to prevent him from doing so at the time. Congress and the IRS were outraged and swiftly passed 280E to make sure it would never happen again.

Fast forward to the present day when cannabis is legal in 33 states medically and in 11 states and the District of Columbia recreationally. For some legal cannabis firms, Section 280E is enough to force them out of business. Consider that California was home to about 2,000 nonprofit dispensaries prior to 2018. Legalization introduced regulations that increased the cost of operation. Bigger dispensaries were able to go to Canada and raise funds on the public market, but most legacy cannabis businesses could not afford to do that, and more than 65% of dispensaries shut their doors, resulting in loss of jobs, sales tax and income taxes.